Dec. 2 (Bloomberg) -- Russia will offer cheaper natural gas
to Ukraine if the government in Kiev opts to join a Moscow-led
economic bloc after halting free-trade talks with the European
Union, according to First Deputy Prime Minister Igor Shuvalov.

Ukraine’s economic difficulties will be best resolved if it
chooses integration with Russia, Shuvalov said in an interview
last month in Bloomberg News’ Moscow office.

“No one other than Russia can provide Ukraine with the
necessary funds so quickly and in such a quantity,” Shuvalov
said. “A gas agreement could help relieve Ukraine of a huge
problem. We can also give them a loan, but we will not help them
without commitments on their part.”

Ukraine failed to sign an EU free-trade accord last week,
suspending talks in order to repair economic ties with Russia.
The country is a key route for natural gas shipments to the EU,
while both Russia and the EU buy about 25 percent of Ukraine’s
exports. Russian President Vladimir Putin’s ambitions for an
economic bloc of former Soviet nations to rival the EU have put
him in conflict with European leaders including German
Chancellor Angela Merkel.

While Ukrainian President Viktor Yanukovych reiterated that
the country’s goal is European integration, his about-face on
the EU agreement has sparked the biggest street protests since
the 2004 Orange Revolution.

Clashes, Protests

Ukrainian protesters are blocking government buildings
after yesterday urging workers nationwide to walk off the job. A
crowd estimated by the opposition at half a million converged on
central Kiev last night, while clashes with police left at least
265 people hurt.

Russia, which supplies 60 percent of Ukraine’s natural gas,
threatened trade measures against its neighbor if the EU deal
went ahead and offered membership in its customs union as an
alternative.

Ukraine would risk the Kremlin-led union with Belarus and
Kazakhstan imposing tariffs on its goods if it signs the EU
free-trade accord, Russian Prime Minister Dmitry Medvedev told
his Ukrainian counterpart Mykola Azarov at a regional meeting in
St. Petersburg on Nov. 20. A day later Ukraine announced it was
halting preparations for the EU agreement, due to have been
signed at a summit in Lithuania on Nov. 28-29.

Third Recession

Ukraine entered its third recession since 2008 in the
second quarter of this year as demand for its steel exports
shriveled, while its international currency reserves have
plummeted. Joining Russia’s customs union would shrink its
current-account gap by cutting energy costs.

Ukraine, the second-most populous former Soviet nation
after Russia, isn’t ready to join the trade pact immediately,
Shuvalov said in comments cleared Nov. 30 for publication.

At the same time, Ukraine knows it will get “a different
price for gas” by making a commitment to become a member of the
customs union like Armenia, which decided in September to join
the group instead of striking an EU pact, he said.

“We’re negotiating in an open and transparent manner with
Armenia about our ties and everyone understands that we are
giving Armenia a specific price for gas because they’re signing
the whole package of agreements on the customs union,” Shuvalov
said.

Armenia will bolster its economic prospects and improve its
investment climate by joining the customs union, Putin said
today while visiting the South Caucasus nation.

Bonds, CDS

The yield on government bonds due 2023 rose 61 basis
points, or 0.61 percentage point, to 10.58 percent by 4:28 p.m.
in Kiev. The cost to insure Ukraine’s debt against non-payment
for five years using credit-default swaps jumped 138 basis
points in the past week to almost 1,065 basis points, leaving
the Black Sea nation the third-riskiest behind Argentina and
Venezuela, according to data compiled by Bloomberg.

Ukraine shouldn’t have to chose between Russia and the EU
as countries “must be able to decide freely” about their
international relations, Merkel told reporters in Berlin on Nov.
27. “The Cold War is over.”

Polish President Bronislaw Komorowski condemned what he
termed a policy of “pressure and blackmail” by Russia in an
interview last week with the newspaper Gazeta Wyborcza.

Russia hasn’t offered to review its natural gas supply
contract with Ukraine, Putin said last week during a visit to
Italy.

‘Political Tensions’

Ukraine will hold talks with Russia in the next two weeks
seeking to set gas prices for 2014 so the government can prepare
a budget, Azarov said in comments broadcast late yesterday by
the non-state television channel Inter.

Countries in the customs union would “immediately stop
free trade with Ukraine” if the country signed the EU deal,
costing the country 400,000 jobs, Azarov said in parliament Nov.
27. The two countries haven’t agreed on new loans and will meet
in December to discuss the way ahead, he said.

It’s not in Ukraine’s interest to sit on the fence without
a commitment to EU association or the Russian-led group,
according to Andrey Slepnev, trade minister in the customs
union’s Eurasian Economic Commission.

“If Ukraine goes neither here nor there, political
tensions will increase in the country,” Slepnev, a former
Russian deputy economy minister, said in an interview last
month. Joining the customs union, on the other hand, “will give
an impetus to the Ukrainian economy.”